When do we use tax expense?

Tax expense is used when we don’t have the right to deduct VAT. Depending on national regulations, there are cases when VAT input cannot be taken as credit VAT / Deductible VAT. For example. if we purchase something that is not for business use.

One of the UK examples:

The input tax on the purchase of cars that have any private used is blocked. Therefore, the VAT on cars with 100% business use, such as stock in trade cars for car dealers, taxis, driving schools, hire cards, pool cars etc. can be reclaimed.

In this case, there are 2 solutions:

  • The VAT amount can be distributed on Inventory (it will go to expense once the COGS is formed);
  • The VAT amount is immediately counted as expense (tax expense account).

We will take an example where we purchase Item 01 by the price of £100, and our vendor calculated VAT £20. Or obligation towards our vendor is £120. We don’t have the right to deduct input VAT.

Deductible (VAT) : NO – Tax expenses

The creation of the PO (procurement)

Purchase order

Automatically created journal voucher:

journal voucher

Creating a sales order (selling):

sales order

Automatically created journal voucher:

journal voucher

Tax preparation report in ERPAG:

tax preparation report

Setting up parameters in QBO:

qbo setup

QBO Bill after the synchronization:

bill in qbo

Transaction journal in QBO:

journal in qbo

QBO Invoice after synchronization:

invoice in qbo

Transaction journal in QBO:

journal in qbo

VAT report in QBO:

vat report in qbo

Deductible (VAT) : NO – Inventory

Creation of the PO (procurement):

purchase order

In this Journal voucher, the amount will be added to Inventory account. There is no Tax expense account in this case.

journal voucher

Now, in the Journal voucher of a Sales order, COGS will be increased in comparison to our previous example, as there is no Tax expense account.

journal voucher

QBO Journal entry and Bill also won’t have tax expense account:

bill in qbo
journal entry in qbo

Invoice journal in QBO:

journal entry in qbo

Conclusion:

When it comes to expenses, the result will be the same at the end of the process. The only difference is the moment of accounting expense. With Tax expense the VAT will become an expense when we receive the goods. While in the other case, the amount of VAT will become an expense once the COGS is formed (in most cases at the moment of selling the goods).

Everyone decides on the type based on national accounting standards and the company’s accounting policy.